Options

A complete definition of ‘options’ in the financial markets context is not a simple black and white task. Yes, it is true that an option is a contractual agreement between two parties, one to sell and one to buy. But there are many different types and styles of options and each one has its own definition, a brief explanations of some of the various meanings are given below.

Options contracts provide both parties with a term sheet that indicates whether it is a ‘call’ option (providing the right to buy an asset/s) or a ‘put’ option (which provides the right to sell an asset/s). The options contract will also indicate the exercise price or ‘strike’ price, the option expiry date; details of the assets that the contract is concerned with, the market quotation terms and of course settlement terms that have been agreed.

Listed options, also known as exchange-traded options are options that are traded derivatives via a regulated exchange. These types of options are traded via a clearing house which in turn guarantees contract fulfilment by retaining a margin from both sides, they have standardized contracts which provide accurate strike price, quantity, asset and expiry date information, with liquidity being one of the main benefits of this type of option. The types of listed options available are futures, equity or index, commodity, stock, bond or interest rate.

Over-the-counter (OTC) options are sometimes referred to as dealer options. These types of options are usually financial instruments that are traded by a broker / dealer network and involve stock, derivatives, bonds or commodities. Highly risky and usually characterized by volatility, OTC’s offer great prospects to those investors that are brave enough to risk this market, which usually involves smaller companies where background information may be limited. The OTC contract is an agreement by two private parties on how a trade will be settled at a future date and is not carried out via an exchange, and commonly involves forwards, swaps or currency rates.